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Investment Overview for Norfolk Southern (NYSE:NSC)

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Rising coal shipments

With the increased use of cleaner sources of energy such as natural gas, the demand for coal has dropped significantly over the last few years. Consequently, the coal shipments have witnessed a sharp decline in the last five years. While higher natural gas prices resulted in a sudden rise in coal shipments in 2017, it is again facing decline in 2018, given slightly lower natural gas prices. In the long run, natural gas prices are expected to move up, augmenting the coal shipments and, in turn, the revenues of railroad companies such as NSC.

Greater infrastructure spending plans to boost prospects of railroads

The U.S. has promised a $1 trillion overhaul of domestic infrastructure, with an emphasis on transportation infrastructure, including railways. Improvements in transportation infrastructure as well as a boost to economic growth from the pro-business policies of the federal government should boost the shipments of railroad companies such as Norfolk Southern.

Decline In Light Vehicle Sales To Hamper Top Line

Since the beginning of 2017, the demand for light vehicles has slowed down, despite large discounts being offered by manufacturers to clear their previous inventories. This is largely because the pace at which cars or trucks are being purchased is not the same as the pace at which they are being replaced. Consequently, there is a void in the demand for these vehicles, which is visible from the decline in their sales year-to-date. Since the railroad sector is closely correlated to the automobile industry, companies such as NSC have witnessed a plunge in the auto shipments during the year.

While the the damages caused by the recent hurricanes could provide some short-term opportunities for the light vehicle market, the full year motor vehicles and parts shipments are likely to come in lower compared to the last year. Besides, this trend is expected to continue into the coming quarters, which is expected to pull down the current valuation of the US railroad companies.

Higher oil prices will aid the overall revenue growth

Fuel surcharges are a component of pricing for railroad companies. Due to a sharp rise in oil prices in 2018, Norfolk Southern's fuel surcharge revenues are expected to increase in the near term. Oil prices (WTI) have already crossed $70 mark in May 2018, reflecting the highest level since November 2014., and are set to average significantly higher in 2019, according to various estimates. This is expected to boost Revenue per Carload going forward.
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Below are the key drivers of Norfolk Southern's value that present opportunities for upside or downside to the current Trefis price estimate:

Norfolk Southern's EBITDA margin: We currently forecast Norfolk Southern's EBITDA margin to increase from 45.6% in 2017 to over 47%, by the end of the Trefis forecast period, driven by the company's productivity improvement initiatives.There could be an downside of over 5% to the Trefis price estimate if margin growth as a result of productivity improvement does not have any significant impact, and margins stay around 45% by the end of the Trefis forecast period.

Coal Freight

U.S. Rail Carloads of Coal: We currently forecast U.S. Rail Carloads of Coal to increase from 1 million in 2017 to 1.2 million by the end of the Trefis forecast period, as natural gas prices are expected to be higher. Also, potential steps pertaining to loosening environmental regulation on coal production by the U.S. government could significantly boost coal production in the country.

For additional details, select a driver above or select a division from the interactive Trefis split for Norfolk Southern at the top of the page.

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Norfolk Southern Corporation is one of the largest railroad companies in the Eastern United States, engaged primarily in the rail transportation of raw materials, intermediate products, and finished goods. Goods are primarily transported in the Southeast, East, and Midwest US, and via interchange services with rail carriers, to and from the rest of the United States. Norfolk Southern also transports overseas freight through several Atlantic and Gulf Coast ports.

Its principal subsidiary, Norfolk Southern Railway Company
is wholly owned. NSC also has a joint ownership, along with CSX, of the Consolidated Rail Corporation. Norfolk Southern's route map covers most of the eastern United States, east of the Mississippi River, the District of Columbia, and the Canadian provinces of Ontario and Quebec, covering nearly 22 states. Norfolk Southern's primary competitor is CSX Corporation which covers much of the same territory.

The company operates on 19,500 miles of track out of which 14,711 is owned outright and the remainder is pursuant to trackage rights or leases. Norfolk Southern offers the most extensive intermodal network in the eastern half of the United States.

Norfolk Southern’s business mix includes coal, intermodal, and general merchandise which is composed of six major commodity groupings: automotive; chemicals; metals and construction; agriculture; consumer products, and government; as well as paper, clay, and forest products. Although the company's primary role is transporting freight, its non-carrier subsidiaries engage principally in the acquisition, leasing, and management of coal, oil, gas, and minerals; the development of commercial real estate; telecommunications; and the leasing or sale of rail property and equipment.

Norfolk Southern's earnings depend upon the volume of freight contracts it sells, and the price of those contracts, while its expenses primarily consist of labor, fuel costs, utilities costs, and track maintenance. The largest of Norfolk Southern's customers include steamship lines, vehicle manufacturers, agricultural companies, utilities, intermodal companies, and chemical manufacturers.

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We believe the Intermodal freight and Chemicals freight divisions are the most valuable divisions and account for more than 40% of Norfolk Southern's total value. The key factors responsible for this are:

Tightening trucking capacity

Declining fleet sizes and inadequate availability of truck drivers have significantly tempered the freight transport capacity of the trucking industry. The Hours-of-Service safety regulation for commercial vehicle drivers has put pressure on trucking capacity by limiting the number of working hours for truck drivers. The tight trucking capacity will lead to high volumes of freight shifting to railroads. As the demand for railroads’ services increase, so will their pricing power. This provides an opportunity for Norfolk Southern to corner a larger share of U.S. intermodal shipments.

Elevated levels of U.S. oil and gas output

Robust growth in U.S. oil and gas output as a result of the shale boom boosted the shipments of the Chemicals Freight division, which transports a range of petrochemicals and related products, over the past few years. Though Norfolk's Chemicals shipments didn't see any growth in 2017, shipments are expected to recover somewhat as a result of the recent increase in oil prices. Current shipment levels of Chemicals freight are enough to make this the company's third most valuable division, though the situation may change if the division's shipments fall sharply due to an extended downturn in oil prices.

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Strengthening coal market

Norfolk Southern's coal shipments have declined in Q1 2018, as a result of lower natural gas prices. An increase in natural gas prices in the long run is expected to boost the share of coal in U.S. electricity generation. Going forward, favorable policy support from the U.S. government could boost shipments further.

How Does Trefis Modelling Work?

How do we get the historical numbers for this chart?

Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.

Who came up with the Trefis forecast for future years?

The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.

How does my dragging the trendline on the chart impact the stock price?

We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.

We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.

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